Danker: 4 Myths About the Gold Standard

Rich Danker|Economics Director, American Principles Project

Tuesday, 4 Sep 2012 | 10:45 AM ETCNBC.com

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Gold coins and bar

For the first time since the age of Reagan, the Republican Party is considering the gold standard. The platform adopted last week at the GOP convention includes a plank in favor of a commission to study the way back to a fixed value for the dollar. Such a commission would jumpstart a national debate on monetary reform, something needed now more than ever. But instead of participating in this, critics have objected with myth after myth about the gold standard.

Here are four of the most popular:

Myth 1: The gold standard leaves no discretion in the economy over the money supply.

This is a common refrain from Federal Reserve officials, including Chairman Ben Bernanke. The truth is that the gold standard does not make the money supply static; it simply shifts control over it from the central bank to the people. When the economy demands more money, people exchange gold for new dollars; when it needs less, they redeem excess dollars for gold. This is the market-guided alternative to the system we have now where the Fed controls the money supply through market intervention based on its interpretation of the economy. (Read More: Steve Liesman Explains the Gold Standard)

Myth 2: The dollar would fluctuate based on the price of gold.

Washington Post opinion writer Ezra Klein offered this objection in a recent column. A more erudite opponent of the gold standard, Milton Freidman, claimed it would amount to the government fixing the price of gold. But the gold standard fixes one thing: the value of the U.S. dollar in a weight unit of gold. Because gold’s value has been consistent through history based on its steady annual supply growth rate (approximately 2 percent), it is the ideal asset to stabilize a currency value. The classical gold standard era from 1879-1914 proved this when overall U.S. inflation was negligible and volatility was low.

Myth 3: The gold standard caused economic depressions.

This is frequent claim from Paul Krugman as well as Bernanke. A more-than-cursory look at the historical record shows the opposite: when American monetary policy got away from gold, bad things happened. The one depression during the decades of prosperity under the classical gold standard era was the Panic of 1893. This was precipitated when the country went off gold because silver was briefly introduced into the monetary system to appease interest groups. President Grover Cleveland undid the mess, but Republican William McKinley won the next two presidential elections based off of his and the GOP’s unwavering support for the gold standard.

By the run-up to the Great Depression, the real gold standard was long gone, replaced by a global monetary system where gold was sidelined from usage. Central banks took up the practice of holding national currencies instead of gold as reserves, eliminating a way for nations to settle their international payment deficits and surpluses. Instead of letting the money supply be determined by the market through dollar-gold convertibility, the Federal Reserve used the crude indicator of wholesale prices to set interest rates, leading the country down the path of deflation. Free-market economists such as Friedrich Hayek warned at the time of the dangers of decoupling monetary policy from the gold standard, but it was too late.

Myth 4: Gold has no particular meaning or value.

There are many smart people like Warren Buffett who deride gold as useless. In response to the gold commission plank, Washington-based financial advisor Ric Edelman joked, “Maybe we should move to a sand standard.” But there is a reason gold beat out every other commodity and became the world’s monetary foundation: it is universally recognized as wealth. This stems from its relative scarcity, indestructibility, and intrinsic appeal. Gold’s long-term purchasing power has never declined, while the history of paper currencies is an extended descent in value. Mocking gold’s role as money requires dismissing centuries of economic history and human experience.

The vitriol against the gold standard shows why the GOP was astute in calling for a study of backing the dollar with gold. The nation’s elites, from the top central banker to local financial advisor, won’t engage in a serious discussion about monetary policy despite the dysfunction around it. The dollar has lost 82 percent of its purchasing power since U.S. monetary policy broke completely from gold in 1971 while real household median income has grown just 19 percent over that span. The paper money standard has robbed working Americans of a chunk of their earnings through long-term inflation. With a weak economy and financial crisis still unresolved, it’s time to look at what worked in the past instead of accepting the broken system we have today.

Rich Danker is economics director at American Principles Project, a public policy organization with an initiative to educate Americans about the gold standard.